Last week, we reviewed our sales forecasts for the third quarter of 2022 and offered our perspective on the factors that continue to present a bumpy road for the auto industry. A replay of that presentation is posted in the Cox Automotive Newsroom.
This week, we are beginning to see more clearly the September data and, as expected, we have a disjointed market with a wide variety of results. In September, Ford sales unexpectedly dropped more than 9% year over year. Toyota, on the other hand, posted a 17% gain. In aggregate, the sales pace was little changed and remains near the lowest pace of sales for the year.
The irony for the auto market is that just as the industry is poised to start seeing volumes increase from supply-constrained recession-like low levels, the rapid movement in interest rates is reducing demand. New cars may finally become more available just when most Americans can no longer afford them, and that does not bode well for a supplier base already on the ropes from three years of low new-vehicle sales.
For much of 2022, and particularly through the first half of the year, we felt vehicle demand was healthy despite tight inventory and high prices. More recently, however, actions by the Federal Reserve are beginning to negatively impact the market. At the end of Q2, consumer sentiment, a key driver of auto sales, appeared to be increasing from a record low in June and indeed saw gains through late summer. But sentiment began to turn in the wrong direction at the end of last month, as we saw significant Fed-induced stock market declines, additional leaps in consumer-facing interest rates, and clear warnings of “further pain in the economy” that were well covered by the media, and even me.
Then, as if by cue, Hurricane Ian ripped across Florida, causing catastrophic damage, and gas prices began inching up. For dessert, we are now in the final month of midterm elections, with an unsure outcome that all but guarantees maximum negativity over the airwaves and on social media. October will be a bumpy ride.
Central to all of this is what the Federal Reserve did to the economy and financial markets late last month: their 75-basis point increase to the Fed funds rate was no surprise and was actually a better outcome than what was possible, as a 100-basis point increase was possible. However, that increase was accompanied by very hawkish plans that changed the outlook for our market in three critical ways:
- There is every indication that the market is in for at least another point-and-a-quarter increase this year and another quarter point early next year, pushing the target rate a full point higher than what they had communicated just back in July. The current level is already considered “restrictive” by their account, meaning it’s intentionally higher than what would naturally be in the economy, therefore forcing the economy to slow. Going beyond that level with the remaining plans is way above restrictive.
- The Fed is now indicating they plan to keep rates restrictive through at least 2025. That means no retreat is expected in 2023, even when the market begins to experience recession-causing job losses.
- The Fed fully expects to see further slowing in the economy. They are using the word “pain” in all their recent rhetoric, and a de facto recession is reflected in their expectations for the rise in unemployment.
As I have noted before, the Fed wants to see less credit flowing as a key part of their plan to induce pain, and they are getting what they want. Credit is still available, but it is flowing to a smaller portion of the population, which means demand is shrinking. Many consumers have limited ability to secure a payment they can afford, as they cannot adjust the remaining variables enough to keep payments within reach. We are now seeing the highest interest rates in 15 years, and that means affordability is eliminating lower income and lower credit quality buyers. Subprime buyers, for example, accounted for 14% of the new-vehicle market in 2019. Now, subprime buyers account for just 5%, and deep subprime buyers have all but disappeared.
At the end of Q3, the new-vehicle loan rate had increased by 2 percentage points for the year. In the used market, loan rates had increased 2.15 points for the year. We expect more movement through the fourth quarter, pushing monthly payments even higher, and we now believe new-vehicle demand may not hold up when new-vehicle production increases and product availability improves.
We have adjusted our 2022 full-year new-vehicle sales forecast down to 13.7 million, a level not seen in a decade. At that sales pace, the industry can expect to see further stress in the supply chain, which may lead to further inventory disruptions.
At the same time, it is likely the higher rates will also reshape the industry into a more concentrated luxury market, where average new-vehicle prices push past $50,000, as automakers chase high-credit, high-income buyers who are less likely to lose jobs in recessions and enjoy the ability to pay cash for new-vehicles or secure lower rates when they choose to finance. With prices at record highs and rates heading higher, the new-vehicle market will behave like a de facto luxury market for the foreseeable future.
As we take a measure of the market in the fourth quarter of 2022 and begin to consider our expectations for the year ahead, I will say the most worrisome issue with the Fed’s plans is that they are not taking the time to see the impact of substantially higher rates. There is an oft-quoted refrain in economic circles that is most appropriate right now: “Monetary policy changes have long and variable lags.”
Translation: The Fed should slow the pace of their actions and take the time to survey the damage before going further. From where I sit, the damage is already clear. The vehicle market is already showing signs of the lethal combination of high prices, limited new-vehicle supply, and now the highest interest rates in 15 years. Vehicle demand is definitely slowing, as the Fed intended. At this point, though, further hard braking may put the industry into the ditch.
Jonathan Smoke is chief economist at Cox Automotive.